How Illegal Taxation Came to Be Common

Long before I started posting things on this blog, I used to write things just for fun. Because I had nothing to do with most of them, many wound up getting deleted or otherwise lost. I don't regret losing most of them as they generally weren't anything more than rough drafts of short essays, but one I do wish I had kept was about what I believe to be illegal taxation by the United States. I put a not insignificant amount of time into researching things for it, and I spent even more time working on how to write it well.

I don't know that I'll ever bother to try to write it all out again. More people have become aware of the issue since I first looked into it, and I don't know that there's really anything unique I have to say. I do want to post a couple comments I just wrote over at lucia's Blackboard though. They give something of an overview/introduction into the general subject.

It's not my best work, by any means, and I'm sure you could probably find better pieces on the subject, but I think it is still worth reading. After all, how many readers realize the United States has spent approximately the last 100 years engaging in taxation practices that are most likely illegal?

Here's the relevant portions of what I wrote:


In the court case Cook v. Tait (1924), a US citizen living in the United States was contacted by the US government with a demand he pay taxes on income he had received. He paid the initial sum required and filed a complaint with the courts, saying that as he lived in Mexico and earned the income there, he shouldn’t have to pay any US taxes on it. The Court ruled against him.

In making this decision, the Court highlighted two previous cases, United States v. Goelet (1914) and United States v. Bennett (1914). In Bennett, a citizen living in the States who owned and used a yacht entirely outside of the country’s territory. The Court had ruled this was a taxable situation. In Goelet, a citizen living outside the States owning and using a yacht in a similar manner was found not to owe taxes. This demonstrated the two distinct conditions at play:

1) The residency of the individual.
2) The location of where the income was earned (or property located, etc).

In Bennett, one condition favored taxation while the other did not. The result was taxes were applied. In Goelet, neither condition favored taxation. The result was taxes were not applied. The obvious inference from this would be that in order to owe the United States government taxes, one must either reside in or earn income (own property, whatever) in the United States. That is not what Cook v. Tait found. In it, the Court noted in Goelet:

Pains were taken to say that the question of power was determined “wholly irrespective” of the owner’s “permanent domicile in a foreign country,” and the Court put out of view the situs of the yacht. That the Court had no doubt of the power to tax was illustrated by reference to the income tax laws of prior years and their express extension to those domiciled abroad. The illustration has pertinence to the case at bar, for the case at bar is concerned with an income tax, and the power to impose it.

Meaning the reason for the ruling in Goelet was the specific tax law in question, not the principle. The principle of taxing people permanently residing outside the States for income earned outside the States was considered sound because:

the principle was declared that the government, by its very nature, benefits the citizen and his property wherever found, and therefore has the power to make the benefit complete. Or, to express it another way, the basis of the power to tax was not and cannot be made dependent upon the situs of the property in all cases, it being in or out of the United States, nor was not and cannot be made dependent upon the domicile of the citizen, that being in or out of the United States, but upon his relation as citizen to the United States and the relation of the latter to him as citizen. The consequence of the relations is that the native citizen who is taxed may have domicile, and the property from which his income is derived may have situs, in a foreign country, and the tax be legal, the government having power to impose the tax.

The few people I’ve met who have heard of this ruling routinely mock this logic, but it is not unreasonable. The principle expressed here is that merely by being a citizen of the United States, one might derive some benefits which justify certain taxations. That is perhaps fair. However, as Goelet made clear:

speaking in a general sense, that the taxing power, when exerted, is not usually applied to those even albeit they are citizens, who have a permanent domicil or residence outside of the country levying the tax. Indeed, we think it must be conceded that the levy of such a tax is so beyond the normal and usual exercise of the taxing power as to cause it to be, when exerted, of rare occurrence, and in the fullest sense exceptional.

This is where things went wrong. Goelet acknowledged the government has the authority to tax people living outside the country for income earned outside the country, but it noted that happens only in incredibly rare circumstances. That is what led the Court to rule the tax law considered in Goelet was not intended to apply to citizens living outside the States.

Cook v. Tait didn’t discuss this issue. While in 1914 the Court held in Goelet taxing power “is not usually applied to those” living abroad, in 1924 Cook v. Tait decided the fact the United States has some potential authority to apply taxes to those living abroad means the standard income tax applies to everyone living abroad. This completely subverted principles in Goelet, principles Cook v. Tait didn’t even mention. Ultimately, Cook v. Tait says:

that power, in its scope and extent, it was decided, is based on the presumption that government, by its very nature, benefits the citizen and his property wherever found,

And that was used to justify imposing all sorts of burdens on US citizens living abroad, regardless of what (if any) benefits their citizenship actually granted them. The Court presumed there were benefits, disregarded the fact applying taxation power in this way was incredibly uncommon, and… there you have it.

It’s utterly absurd. It’s even more absurd when you realize it’s not United States citizenship that is supposedly beneficial – it’s United States “government, by its very nature.”


By the way, the reason this even happened was absurd as well. It used to be there non-resident US citizens were a rarity. Most of them were wealthy, able to leave the country to avoid the draft. Add to that the income tax only applied to the upper class at that time, and one can begin to guess why this measure would be desired - to at least attempt to treat the wealthy citizens of the United States who fled the country in times of crisis (especially to avoid things like the draft) equitably to everyone else.

Now fast forward to a time nearly a hundred years to a point where the income tax applies to the not just the upper class, but also the middle class, and the demographics have shifted so that non-resident citizens are common rather than the rarity they were of those times, and the draft no longer exists for people to dodge by leaving the country. Does it make any sense to continue practice, given the original reasons for it were both wrong, and are don't even remotely apply anymore?

I would say no. That's not what we're seeing though. Instead of backing off from this practice, trying to move away from it, we're actually seeing the government step up enforcement. When this practice was first implemented, it was almost entirely a symbolic measure. There was no practical way for the US government to collect taxes under this idea. Now that there is, the government is wanting to collect on them more and more. That the justifications for the entire practice grow weaker with each passing day doesn't seem to matter.

Personally, I think the entire practice is unconstitutional and should be challenged as such.

5 comments

  1. Whilst you mention income tax surely there is a much bigger concern which relates to the tax that US corporations (most usually) pay? Pfizer are in the news at the moment regarding a merger in order to shelter tens of billions of Dollars offshore.

    In Britain and Europe we have new giant American Corporations such as Amazon and Google making huge sums out of the local economies but paying no tax at all to the Govt of their host countries. Other big corporations are similarly also using sharp practices to circumvent taxes.

    In effect these are 'non resident' corporations responsible to no one and paying tax to no one. Surely a much bigger problem than the income taxes of a few private individuals.?

    tonyb

  2. Tonyb, I can't agree corporate tax issues are a bigger concern. While I understand people may not like large corporations exploiting loopholes to avoid paying taxes, there is nothing wrong with it. Individuals and small companies do the same thing. The only difference is what loopholes are available to them.

    If countries want to change their tax laws to eliminate loopholes used to avoid paying taxes, they can. Most tax laws should probably be revised, but actually getting it done has always been difficult. I suppose it might happen here because people are always happy to view large corporations as the "bad guys," even if it is entirely illogical.

    The difference is all that involves legal issues and potential reforms to legal laws. I find unconstitutional, or outright illegal, laws far more troubling. People can disagree about how tax laws should be structured, but those disagreements are of a different sort than protesting abuse of government powers. Especially when it's been going on for something like a century.

  3. Here is a look at just siz big American corporation collectively earning over 20 billion dollars in uk sales annually and paying less than half a percent in taxes.

    http://www.mirror.co.uk/news/business/six-firms-including-google-facebook-5081824

    They just shift the money around in an a effort to avoid paying their fair share. If they earn money from Britain they should pay a reasonable amount in taxes. Pfizer are pulling the same trick. There is nothing illogical about complaining about it

    I am not disputing your particular point just raising another one

    Tonyb

  4. Sure, and that's a product of poorly designed tax codes. People have a natural incentive to try to look for ways to reduce their tax burden. Sometimes they can find ways which reduce that burden by an amount that seems unfair. They shouldn't be blamed for that. We shouldn't anyone to pay more in taxes than they need to. What we should expect is lawmakers to try to ensure taxes are applied fairly, something which didn't happen here.

    Lawmakers generally know tax laws need to be revised. They generally choose not to do so because it is difficult to reach agreements on what the revisions should be, and whatever changes they make will inevitably upset some people. So because the task difficult and unpopular, they choose not to do it... even though they know it should be done.

    I have no problem with people complaining about the situation. I just think people should put the blame where it belongs. We can either blame lawmakers for shirking their duties, or we can blame companies for not voluntarily paying more in taxes than they are required to pay. I say choosing to do the latter is illogical.

    I say blame the people who make the laws, not the ones who follow the laws.

  5. There should be a policy of letting the corporations repatriate money without penalty. Normally a corporation isn't taxed on foreign earnings until the money is repatriated. Tax "shelters" have a sort of negative connotation associated with them when in fact they're just ways of optimizing tax consequences within the existing structure of the law.

    As a student of taxation in college (it actually is a fairly interesting subject), one quote comes to mind from Judge Learned Hand, who said,
    "Anyone may arrange his affairs so that his taxes shall be as low as
    possible; he is not bound to choose that pattern which best pays the
    treasury. There is not even a patriotic duty to increase one's taxes.
    Over and over again the Courts have said that there is nothing sinister
    in so arranging affairs as to keep taxes as low as possible. Everyone
    does it, rich and poor alike and all do right, for nobody owes any
    public duty to pay more than the law demands."

    That the laws may be poorly drafted is in some matter opinion and some matter policy goals. To me, it makes sense not to artificially keep money out of the country for fear of tax consequences when that money can help the economy by being put to use here (and I mean by the corporations, not in the form of taxes). I'd favor allowing corporations to pay their foreign taxes (which they do, and for which we have treaty agreements and foreign tax credits).

    It's more sinister to hide non-income taxes that come in the form of regulatory fees or litigation costs which are politically motivated.

    As to offshore earnings, the IRS has always had a policy of "tax now - ask questions later" if the taxpayer bothers to contest.

Leave a Reply

Your email address will not be published. Required fields are marked *